Update on Executive and Employee Compensation in Government Contracts

The Government is in constant pursuit of later for ways to save money and, for many in the government, there is no better place to do that than on the backs of contractor that serve it. A popular target with the current Administration is the area of executive compensation. It seems not enough that shareholders keep this in check. The government also feels it need inject itself in this market-based equation with hard and fast rules. It has even seen fit on occasion to create rules where there are none, using the Defense Contract Audit Agency (DCAA) as its sword. With respect to rules, there exists the prospect of political restraint. Also, where the Government oversteps its bounds, there are Courts that sometimes rein it in.

On the rulemaking side, Congress amended 10 USC § 2324 this past year to provide that the cap on allowable executive compensation reimbursed on cost-based contracts (currently $693,951 annually, including wages, salary, bonuses and deferred compensation) now applies to “any contractor employee.” It applies not only to prime contractors but also to subcontractors at any level. This does not mean that contractors are limited in what they can pay employees; rather, it simply serves as a limit on what can be reimbursed on a government contract. Accord 48 CFR 31.205-6(p). Additionally, allowable amounts are also subject to the requirements that the compensation be “reasonable and allocable.” This reasonableness requirement is where DCAA has recently been chastised for its views.

In Appeal of J.F. Taylor, Inc., ASBCA No. 56105 (January 18, 2012), the Board rejected the government’s challenge to a contractor’s executive compensation model that considered both the revenues of the whole company and its superior performance, as anyone with experience in the private sector would expect. The government instead tried to rely upon DCAA’s approach that simply mechanically applied a median executive compensation number loosely based upon a market survey unrelated to the contractor at issue. In its decision, the Board accepted the contractor’s unrebutted expert testimony that “the methodology used by DCAA was fatally flawed statistically and therefore unreasonable.” The Board also went on to reject the DCAA expert, saying “the government effort to support its own methodology was supplanted by an expert witness of questionable judgment.” That is harsh by any standard, but appropriate given the circumstances.

What we take from this is that Executive Compensation Reviews (ECRs) by DCAA will continue, and that they may morph into wider reviews. However, the silver lining is that Courts and Boards seem to willing to scrutinize government positions on compensation that do not make sense; this may give the Government pause. It is often a battle of the experts, and this writer can personally vouch for the expert used by J.F. Taylor in its case, namely Jimmy Jackson (having seen his excellent work myself). It remains to be seen whether the Government will appeal J. F. Taylor; they have until May 17, 2012 to do so. Regardless, the Government must deal with DCAA’s methodology on ECR reviews which, at present, is considered fatally flawed. We recommend that any contractor undergoing an ECR seek competent counsel for assistance. It could make a big difference to your bottom line!